managerial economics

paper 1

In the market for medications, there is a difference in demand for medications that are under patent, medications that have a strong name brand, and medications that are generics. Discuss the differences in demand for these three different types of medications. Be sure to discuss these differences using the concepts of price elasticity of demand, cross price elasticity of demand and income elasticity of demand.

The prices of some brand-name pharmaceutical drugs rise when equivalent, generic brands enter the market. When a patent for a highly profitable drug expires, many firms produce generic versions. The government allows a firm to sell a generic product after a brand-name drug’s patent protection expires only if the generic-drug firm can prove that its product delivers the same amount of active ingredient or drug to the body in the same way as the brand-name product. Generic drugs are a large and growing part of the pharmaceutical market. We must ask ourselves what are the characteristics of demand and supply of the Pharmaceutical Industry? By this I mean what are the price elasticities of demand and supply. Price Elasticity refers to the responsiveness of demand and/or supply to a change in the general price level of Pharmaceuticals. (Hunter, 2012). The criteria to determine the price elasticity of demand are; the importance in consumer’s expenditure, is it a necessity or a luxury, and the degree to which legitimate substitutes exist. And in the case of Pharmaceuticals, its demand is relatively inelastic. Pharmaceuticals are very important in consumer’s expenditure, as clearly pharmaceuticals are important for the wellbeing of the consumers, they are necessities for those who are unwell and being treated for an illness. Furthermore, the criteria to determine the price elasticity of supply are; whether there is a stockpile of the good and/or are they easily produced, manufactured or agricultural. And by these determinants it is easy to say that the supply of pharmaceuticals is relatively elastic, as it is a manufactured good which is produced in large quantities. (Hunter, 2012).

A good question to determine progress would be, how can pharmaceuticals use the price elasticity’s of demand and supply to their advantage? Limit the supply to the market and artificially set a minimum price above equilibrium.

A firm’s profit is determined by taking the total revenue minus the total cost. Total revenue is equal to the price each unit sells for times the quantity or number of units sold. We will focus on total revenue in this section and leave the discussion on costs for later. Own price or demand elasticity measures the percentage change in quantity demanded divided by the percentage change in the price of the good. Due to the law of demand, the sign will always be negative, so it is common to consider only the absolute value when analyzing the own price elasticity. (Kaplan, 2002). If something is elastic it is responsive, flexible, or readily changed. A rubber band is elastic and with little force it easily stretches. A chain on the other hand is rigid and changes very little when pulled. In the context of price elasticity of demand, the price change is comparable to the force applied to a rubber band or chain and the change in quantity demanded is comparable to the stretch. When consumers are relatively responsive to a price change, we say that demand is elastic. When the change in quantity demanded by consumers is relatively small in response to a price change, we say that demand is inelastic. If the percentage change in quantity demanded is greater than the percentage change in price, the elasticity is greater than one and the good is classified as elastic, meaning the percentage change in quantity demanded is relatively responsive to the percentage change in price. (Kaplan, 2002). An elasticity of demand less than one is classified as inelastic, meaning the percentage change in quantity demanded is relatively unresponsive to the percentage change in price. The cross-price elasticity measures the percentage change in the quantity demanded for one good, say good x, given the percentage change in the price of another good, say good y. The elasticity is compared to zero. If the cross-price elasticity of the two goods is negative, they are considered complements. Complements are consumed together so an increase in the price of digital music players, e.g., iPods, would lead to a decrease in the quantity demanded of online music downloads, e.g., iTunes. (Kaplan, 2002). When the quantity demanded doesn’t change as the price of the other good changes, the goods are unrelated and have a cross price elasticity of zero. The last elasticity measure is income elasticity which measures the percentage change in quantity demanded given a percentage change in income. Goods and services with negative income elasticities are inferior goods and include items such as dry milk and second-hand clothing. As incomes rise people buy less of these goods. Goods with positive income elasticities are normal goods and can be divided into two additional categories, those between 0 and 1 are necessities and those greater than one are luxury items. A one percent increase in income leads to more food, water, clothing, and housing but the quantity demanded increases by less than one percent. Quantity demanded of luxury items such as jewelry, leisure travel, elective surgery increase by more than one percent given a one percent increase in income. When incomes fall, the quantity demanded for these luxury items also falls by more than the percentage change in income.

References:

Kaplan, J. (2002). Elasticity. Retrieved January 24, 2017 from http://spot.colorado.edu/~kaplan/econ2010/section4…

Hunter, C. (2012). The ‘push and pull’ of the Pharmaceutical industry. Retrieved January 24, 2017 from https://myindustrygroupblog.wordpress.com/2012/10/…

paper 2

Patent drugs have highly inelastic demand. Patent drugs do not have an exact (or close) substitute. This does not exist. Buyers are not price sensitive to price increases when substitutes are not available. Cross price elasticity is negative with other drugs. There are other drugs that can resemble patented drugs. For example, Walmart has complementary brands (Great Value)that are similar to patented drugs. The drugs become normal goods when buyers use the drugs irrespectively due to the rise and fall of their income. Income elasticity becomes close to zero.

Brand name drugs also have inelastic demand with a low response in price. Brand name drugs price response is not as low as patented drugs. The Cross-price elasticity with non-patented drugs usually is positive because of substitute drugs. “The important point is that the cross price elasticity of demand is the measurement of the percentage shift in the demand curve for the substitute or complementary good (Graves & Sexton, 2009).” The income elasticity becomes zero to positive due to buyers with higher incomes tend to by better quality drugs.

Generic drugs have a high elastic demand and a high price response because generic substitutes are available. Many substitutes exists making cross-price elasticity positive. Income elasticity becomes negative or decreases. “Income and price elasticity of demand quantify the responsiveness of markets to changes in income and in prices, respectively (Sabatelli, 2016).” When the buyer has a higher income they tend to buy brand or patent drugs instead of generic.

Graves, P. E., & Sexton, R. L. (2009). CROSS PRICE ELASTICITY AND INCOME ELASTICITY OF DEMAND: ARE YOUR STUDENTS CONFUSED? American Economist, 54(2), 107-110. Retrieved from http://search.proquest.com/docview/603216498?accou…

Sabatelli, L. (2016). Relationship between the uncompensated price elasticity and the income elasticity of demand under conditions of additive preferences. PLoS One, 11(3) doi:http://dx.doi.org/10.1371/journal.pone.0151390